« One meal at Per Se | Main | What's wrong with long books? »
Pop!: Why Bubbles are Great for the Economy
Bubbles leave behind an economic infrastructure that spurs later growth. The telegraph and railroad bubbles of the 19th century gave birth to modern communications and transportation. The fiber-optic bubble of the 90s paved the way for YouTube and MySpace. Might we need a "green bubble" to solve current energy problems? So argues Daniel Gross, Slate.com and NYT columnist, and also blogger.
I can think of two mechanisms:
1. The bubbly asset price spurs overoptimistic innovators, thus counteracting the tendency to underinvest in new ideas (which are public goods to some extent)
2. The bubbly asset price spurs clusters of production, which help overcome the fixed costs of innovating with a new technology. I am reminded of Andrei Shleifer's seminal work on implementation cycles.
Of course Gross is smart enough not to defend all bubbles. Perhaps bubbles are best when an economy has the potential for breaking through to a new high-growth mode; that would cover today and the mid- to late 19th century. I am less convinced by his treatment of the 1920s bubble, which he cites as beneficial in paving the way for the New Deal. I see a smoother economic path as having brought the better parts of the New Deal without so many of the overreactions.
Gross argues that government should support many bubbles instead of choking them off. At the very least, bubbles are underrated. This is a stimulating book, worth your time and money.
I am of course interested in the cross-sectional cultural contrasts. Paintings are resold for profit, and they are possibly bubbly assets, but CDs are not. Does that make the artistic market more supportive of innovation than the music market? Are bubbles beneficial in the auctions for book contracts? Was this book the result of a bubble?
Here is an FT review.
Posted by Tyler Cowen on May 1, 2007 at 06:09 AM in Economics | Permalink
Comments
I would argue that the only good bubbles are productive-driven bubbles. The bubbles in railroads in the 19th century and telecom-internet in the 1990s have been good for the economy because there was a clear path to substantial improvements in national productivity. Whereas the Dutch tulip bubble and the now past bubble in real estate were not good bubbles because the effect was just wealth transfer from buyers to sellers with no improvements in productivity.
Posted by: brian at May 1, 2007 8:07:23 AM
Our Brave New World, about risk, addresses this issue, but makes the important point that there are different types of investment bubbles. Two key types are asset bubbles vs infastructure bubbles. Bubbles in assets are bad since they can mess the money market, infastructure bubbles are ok because they leave behind the infastructure.
Posted by: aaron at May 1, 2007 8:07:45 AM
If you lived in Philadelphia you wouldn't dismiss the real-estate bubble so quickly. Neighborhoods that were neglected for decades have started to see investment - and private investment, as opposed to the heavily subsidized housing we've seen in the past. Much of it is undoubtedly overpriced, and many of the investors will be disappointed when the pop comes. But one result is a new influx of middle-income residents who are less inclined to support the city's old-line, rent-seeking labor/political class in local elections. You wouldn't necessarily want to be a participant in this bubble, but it's worth cheering on from the sidelines.
Posted by: ac at May 1, 2007 8:38:34 AM
I am confused
Hasn't the cost of recording and distributing music gone down since the high tech bubble? Isn't there a bubble of indie music right now? Musicians are no longer constrained to recording in six figure recording studios, does this count for something?
Even if CD's aren't "bubbly assets" why do I know so many people who own, operate, and otherwise work in recording studios that otherwise wouldn't have existed 20 years ago? Are old analog recording devices that only be found on Ebay or vintage music stores "bubbly assets"?
Why do I know so many professional pop musicians who are totally independent of the traditional record company infrastructure? Why does Austin have so many?
Am I totally missing the concept?
Posted by: steveintheknow at May 1, 2007 9:16:44 AM
Wouldn't Gross's "green bubble" be a lot more like the Apollo program than a true bubble?
Apollo involved vast amounts of federal funding & control to reach supposedly important national goals that ultimately were dead ends. Yes, a basic space-industrial capicity was created, but that lead in turn to other dead ends like the Space Shuttle and a general discouragement of private space commerce.
And what's the likelyhood that Daniel Gross would support a truly privately oriented bubble, as oppose to a "New Apollo" run by smart technocrats like Daniel Gross?
Posted by: Tyler Not-Cowen at May 1, 2007 9:20:33 AM
Bubbles destroy capital through malinvesrment. Where is the benefit?
Posted by: Russ Nelson at May 1, 2007 9:21:26 AM
Does this mean that Krugman is going to stop predicting bubbles every year?
Posted by: rick at May 1, 2007 9:26:50 AM
Bubbles destroy more than financial capital. They sometimes destroy companies/industries and, with them, intellectual capital.
I suppose it could be argued that this intellectual capital is then diverted into other companies/industries, but I'm not sure that's efficient.
Posted by: fustercluck at May 1, 2007 9:54:10 AM
Jason Potts wrote a great article on the role of bubbles as a productive
feature of capitalism several years ago in an Australian economic policy
magazine. I think the article was called "Liberty bubbles".
Posted by: PEmberton at May 1, 2007 10:15:24 AM
What nonsense. Credit bubbles cause savings to flow into what ultimately prove to be unprofitable ventures when the inevitable crash comes. Sure, some of this malinvestment gets salvaged at a later date and turned into profitable ventures, but much of it simply becomes stranded and obsolete- this is a dead weight loss, a loss greater than you would have seen absent the original bubble. And on the flip side, what would have been profitable ventures often get starved of investment because the bubble has diverted the flow of funds to some other pursuit that was temporarily more profitable.
What the author seems to be arguing is that we inflate the economy and keep it inflated. To the best of my knowledge, this has never worked.
Posted by: Yancey Ward at May 1, 2007 10:32:27 AM
Just wondering, other than asthetics, did Holland's tulip bubble have any positive aspects?
Posted by: Allan at May 1, 2007 10:42:04 AM
Allan, how much is a bad example worth?
Posted by: Nancy Lebovitz at May 1, 2007 11:04:46 AM
I'm not persuaded that sparking the New Deal, aka the massive socialization of the American economy, is an argument for market efficiencyr.
Posted by: James Joyner at May 1, 2007 11:10:01 AM
I see four big problems with bubbles.
1)Owners of capital wind up with less future capital, and aside from their own pain there are also negative spillover effects.
2)The unseen, as Yancey Ward astutely points out. This is huge, and is what the tax and spend (or borrow and spend) crowd seem to manage to miss or prefer to finesse away. Yes, we had lots of helpful IT investments made during the late 90's. But we also had companies that had much more expensive capital in other industries as a result, as well as a significant deadweight loss of good things that simply never happened. Compounded over time this slower real growth in other sectors is quite expensive.
3)Human capital gets radically misdirected, first into careers that are far from optimal for them and for society, and after the bubble pops people are loathe to enter that sector for a long period of time who otherwise would have been ideal for that sector.
4) Bubbles are negative economic shocks. Depending on how accurate your model is they are exogenous or endogenous. Either way, the accounting aftermath often means a recession or strong slowdown in sectors that have nothing whatsoever to do witht he bubble in question. An illusion of permanently increased demand for all kinds of spillover sectors also gets popped whent he main bubble pops, thus the pain is spread out beyond the fools.
Bubbles are nothing more than a destructive misdirection of assets to what may or may not have been a kernel of a good idea. To the extent that the good idea had merit, then the best you could say about bubbles is that in those cases there is a silver lining. However much better would've been if the silver could've been produced without a bunch of morons also piling onboard resulting in a terrible cost.
There is a green investment rush to produce technologies that reduce or eliminate carbon emissions. Assume, correctly or incorrectly that this basic premise is sound, namely that GHG's are in fact GHG's. This investment rush includes some high risk investments in things that will never pan out due to unforeseeable technology hurdles or superior alternatives produced elsewhere, and this is fine.
What is not fine is the corn ethanol boom, which is in my opinion a virtual 100% waste and arguably net destructive thanks to increased smog (i.e. old fashioned pollution). Someday I suspect that we'll have a farm waste ethanol boom in things like corn stlaks that would've been thrown away as the corn gets sold for food use. Not only is this not enhanced by the ethanol bubble, but it is delayed due to the misdirection of both financial capital but human captial as well.
There is no silver lining in the bubble part of the current green gold rush such as corn based ethanol, but there is a strong positive aspect of the nonbubble part of the investment boom, namely in things like new materials research and ultracapacitors. It is important not to think that the latter risky positive parts are in any way enhanced by the negative bubble parts.
Posted by: happyjuggler0 at May 1, 2007 12:05:26 PM
What, pray tell, did the new deal fix?
Posted by: ricpic at May 1, 2007 12:12:46 PM
Yancy, while I totally agree with your post, in the "OK" bubbles described, the deadweight investment isn't quite as severe as we see since much of the investment that happens would have just been dead weight investment in other sectors, and probably leads to better investers being able to invest in other sectors. I don't take the arguement that bubbles are good seriously, but they aren't likely as bad we generally think of them. What is probably the worst effect of a bubble is the aftermath, where people become excessively afraid to invest.
Posted by: aaron at May 1, 2007 1:27:05 PM
I think I see a version of the "Junker fallacy" previously described here by our hosts. Capital isn't "destroyed" by a bubble. Financial capital is simply calls-on-resources. You could burn the paper or randomize the electrons and no productive capacity has been eliminated.
Now, it is true that productive capacity being created during a "bubble" (i.e. factories, infrastructure) may be allocated sub-optimally with regards to medium-term demand, but I think I can see the point being made here. Imagine that two equilibrium states exist for the economy, A & B, with B being one where there is higher consumption. The trick is, you can't easily get from A to B because none of the individual actors feels like taking the risks associated with investing for state B while state A obtains. The idea here, if I understand it correctly, is that the bubble basically fools everybody into investing for B. There is a deadweight loss, of course, but does it necessarily follow that the deadweight loss must be greater than the gains from moving to equilibrium B? (Maybe it isn't a good process even if the deadweight loss is smaller; you don't know ahead of time that equilibrium B exists, so on a risk-adjusted basis the bubble is a bad idea anyway?)
Posted by: Bernard Guerrero at May 1, 2007 1:48:09 PM
Bernard,
I suppose an omniscient being might be able to discern states A and B, and know which is better, but I don't know of any of these gods operating in government.
And, yes, capital is destroyed by bubbles if it cannot be converted to other, profitable purposes after the crash- and this is often the case.
Posted by: Yancey Ward at May 1, 2007 2:24:47 PM
Yancey,
I suppose an omniscient being might be able to discern states A and B, and know which is better, but I don't know of any of these gods operating in government.
Yancey, surely you jest! Iosif Vissarionovič Džugašvili! :^)
(I'm only three-quarters kidding. Presumably there's a similar effect regarding the massive application of capital involved in forced-draft industrialization, insofar as there was a pre-industrial Russian equilibrium and an industrialized equilibrium that the economy couldn't easily get to. And deadweight losses and gigantism inbetween....)
Posted by: Bernard Guerrero at May 1, 2007 2:48:24 PM
Bernard,
I will hazard a guess that was Stalin's real name? At least, the "Joseph" seems identifiable.
Still, I am not sure any lesson, three quarters or otherwise, can be drawn from the Soviet experience since neither the before or after had any real resemblance to a classical free-market founded on property rights and freedom of contract. And, in any case, I don't see how the millions who died prematurely were better off afterwards.
Posted by: Yancey Ward at May 1, 2007 3:00:20 PM
Getting back to music: While there is no bubble in the price on individual CDs, there is very definitely a bubble in individual artists.
When 100 000 people pay $80 to attend the concert of someone like Britany Spears, there is no argument that they are doing it based on the objective assessment of her musical talent. They are doing it because she is popular. The more popular she is, the more other people want to see her concerts and buy her music.
Then 5 years later it's "Britney who?"
Posted by: doctorpat at May 1, 2007 7:45:30 PM
I don't think a green bubble is the answer to our current energy problems. A green bubble would more than likely end up in spending money on energy types our nation doesn't need and in turn will be more money wasted. I believe the rich would get richer for a short period of time and the bubble might help for a short period of time but would probably cause an economic crash in the industry. I think the attention and money needs to go towards alternate energy solutions which are better for the environment and by helping the environment, these forms of energy production will last longer than traditional forms.
Posted by: t-rav at May 1, 2007 10:06:15 PM
We can all make arguments against or in favor of bubbles,
but the main point is that they seem to be an inherent
part of the creative destruction of market capitalism.
this is part of the problem I have with the way economics
is taught in out schools. We teach that markets are efficient
and give the impression that it means markets are not wasteful.
But anyone with any knowledge of how markets really work understands
that markets are virtually never in equilibrium -- they are almost
always overshooting in one direction or another. Generally it is just a matter
of whether they overshoot by a massive amount or just a little.
But this is not to argue that markets are bad or perfect as some want to argue, rather it is just that the are generally better then the other alternatives.
Posted by: spencer at May 2, 2007 10:16:24 AM
happyjugler0
Good analysis. Where there are significant 'spillover effects' then there is a beneficial effect: public goods which are created, which the original investors cannot fully capture.
I would argue this is more or less what has happened in Korea, which has the most advanced broadband market in the world. I think something like 70-80% of Koreans have broadband, and the current standard is 10mpbs.
Similarly the 'US Interstate Bubble' had effects (like decline of urban neighbourhoods, and increased gasoline consumption) which we may now decry, but it undoubtedly had huge positive spillover effects on the US economy in terms of productivity gains.
It's difficult to see that the Reagan defence spending bubble in the early 80s had similar effects (there was significant crowding out going on, in terms of raised inflation rates, and hence higher interest rates), but the earlier Space Race/ Missile Gap boom of the 1960s led, indirectly, to the internet as well as other marvels (GPS etc.). Maybe the Reagan one gave us cheaper passenger airliners?
On green tech, the Stern Review has a good summary of R&D spillovers:
http://www.hm-treasury.gov.uk/media/9A3/57/Ch_16_accelerating_technological_innovation.pdf
http://www.hm-treasury.gov.uk/media/8A7/01/ster_review_supporting_technical_material_terry_barker_231006.pdf
Your point about the 'ethanol bubble' is very well taken. We are going up a blind alley, in all best evidence, and the result will be a lot of written off capital.
Posted by: Valuethinker at May 3, 2007 3:17:11 AM
The blog below has some excellent comments about the ethanol 'industry' from a chemical engineer in the oil industry, with a masters degree in the production of cellulosic ethanol.
http://i-r-squared.blogspot.com/
His attention the problems of ethanol, that the promoters are brushing over, is excellent. The core problem remains: for corn-based ethanol, energy out is much less than energy in, including all the inputs of transportation, fertilizer and pesticide, as well as distilling.
(sugar cane ethanol, a la Brasil, is somewhat different)
Biodiesel, which is an economically far more sensible fuel, is an ecological disaster. The problem being the demand for palm oil causes the Indonesians and the Malaysians to bulldoze rainforest.
http://www.biofuelwatch.org.uk/
Posted by: Valuethinker at May 3, 2007 4:53:29 AM
CDs are not bubbly, but music catalogs are - (i.e. the rights to, say, the Beatles catalog). That would be a better analogy to paintings, I think.
Posted by: Cfoster at Jun 1, 2007 2:16:34 PM
Posted by: 鑽石 at Apr 2, 2008 8:34:31 PM
